Staking

Staking

This is a process of storing funds using cryptocurrency wallets, which additionally provides support for all other operations carried out within the blockchain. In fact, this is the blocking of a certain amount of funds to guarantee the reliability of all processes, which is subsequently rewarded. The very idea of staking is closely connected with the Proof of Stake mechanism or PoS, an alternative to the Proof of Work mechanism, PoW. Which has recently been gaining momentum among cryptocurrencies.

History of creation

Most likely, the first were Sunny King and Scott Nadal who introduced the Proof of Stake principle in 2012. It was this principle that lay at the basis of the innovative Peercoin cryptocurrency they developed. Well, not only Peercoin — initially, the blockchain also worked on PoW, which made it possible to work out and polish the interaction mechanism. Yes, and provided greater stability due to proven techniques in the early stages of launch.

In 2014, a certain Daniel Larimer finalized this principle by creating the “Delegated Proof of Stake Mechanism” — DPoS. It was tested within the Bitshares network and turned out to be so effective that other cryptocurrencies gradually began to switch to it.

The essence of the principle was that a fixed balance, which serves as the basis for staking, provided an independent confirmation of reliability and at the same time served as a “vote” for choosing delegates to whom it was possible to transfer the right to be responsible for the reliability of the processes. And these delegates were further responsible for security and consensus building. But as already mentioned, coins from a fixed share (stake) could still be used to receive remuneration for holding funds.

All this was necessary to reduce the number of nodes that verify the authenticity of transactions. Now there was no need for each individual miner to check the data for correctness — selected nodes did that. The fee for skipping unverified data was funds held at the holding, so the elected delegates had a lot more responsibility than the rest of the network participants. It reduced the time of operations and increased network bandwidth. However, the whole system has become less decentralised and somewhat less resistant to external influences.

How does it work?

So, staking is the process of storing funds, which ensures the overall operability of the network and serves for receiving a certain reward. Many modern cryptocurrencies exist precisely due to the Proof of Stake (PoS) system.

Unlike the Proof of Work (PoW) system, where the mining process calculates reliability of each new block in the chain, which required hardware and power costs, PoS systems works differently. The guarantee of the authenticity of each new block in the chain is the means fixed in the stakes. This eliminates the need to use hardware (ASIC). The guarantors of the authenticity of the new blocks in the chain are selected based on the number of coins that they have in the stake.

The more money is stored, the higher the likelihood that a particular node will be chosen, but even those with minimal stakes still have a chance to become guarantors. Unlike the PoW system where there is almost an unconditional advantage for those who have invested more in mining power. So to connect to the new blockchain, you only need to buy the specific currency used in it. And different networks use their own types of cryptocurrency.

A more advanced version of the PoS principle is DPoS, Delegated Proof of Stake. Users can delegate their confirmation authority to certain network nodes. And these representatives already guarantee the accuracy of transactions, are responsible for achieving consensus and determine key network management parameters. At its core, it is a “democratic principle”, only with the ability to clearly monitor the activities of persons who have been delegated the authority to act on behalf of the other network members.

Network inflation

In some PoS and DPoS networks, the remuneration for storing funds is a fixed percentage that depends on network inflation. This encourages users to actively implement their contributions, including through staking. This rewarding method at least compensates the participants for the depreciation costs of the network.

For example, the Stellar network weekly distributes inflation among holders who provide their shares in the pool for staking. It allows receiving a fixed, controlled and regular interest rate.

So, for example, a node holding 10,000 coins on its stack (in this embodiment, XLM) can count on a regular (each time a transaction is credited) reward of 100 XLM, with a steady inflation rate of 1 percent per annum. And this will happen throughout the year if external factors do not intervene and the inflation rate does not change.

This principle allows each member of the network, especially if the system supports a staking pool, to count on a stable share, depending on the funds contributed to this pool. Plus fully predictable payouts and complete transparency of all processes. For some, this is a much more attractive option than competition for block rewards.

Staking pool

This is a situation where several users combine their stakes to increase the likelihood of being selected as guarantors. And then they divide the “remuneration for the block”, commensurate with their share in the total pool.

This system is especially effective in networks with a high “entry threshold”, be it financial or technical limitations. However, the pools also need to be maintained somehow, which is quite difficult for the ignorant. Therefore, the creators and owners of pools often take themselves an additional percentage of the remuneration received. In addition, they are the ones who solve issues related to the withdrawal of funds, cancellation of obligations, the minimum “input share” and other organisational issues. Such pools with transparent interaction processes is good for attracting newcomers. And creation of new pools increases the level of network decentralisation.

Cold staking

Everything described above is typical for the so-called “hot staking” when there is a constant connection between individual network participants. But there is also “cold staking” when the amounts are not circulated in the system or in the general pool but stored on a physical medium — a hardware wallet. There are systems where only such “cold stakes” can act as a guarantor, and once the user transferred his/her currency from them, reward receiving process stops. This method is extremely beneficial to large holders, as it provides stable remuneration with high security of financial reserves.

Conclusion

“Proof of Stake” is becoming increasingly popular among cryptocurrencies. And an increase in the number of stakes gradually increases the entry threshold — it is necessary to acquire ever-larger amounts in order to gain access to the system. Therefore, some cryptocurrency exchanges provide new players with a “basic set”. And withdrawing the remuneration becomes possible after successfully covering this “advance”. However, it does help attract new players.